As the year wraps, many of our Batch 11 Accelerator companies have expressed interest in fundraising in 2015.
We fund a lot of early stage companies here at 500 (850 and counting), most of them before their seed rounds via our Accelerator.
Image Source: CB Insights
We naturally get to see many of these startups’ seed fundraising process from start to finish. Many of the companies we observe approach seed fundraising thinking they want to raise $1M or $1.5M…but a $1M raise is an arbitrary number that most founders think they want to raise.
Raising an arbitrary amount of money for their seed is one of the most common mistakes a founder can make — it also happens to be one of the deadliest.
The LaunchBit Story
At my company LaunchBit, we raised $1M on a note in very unstrategic way.
When I went out to raise again, investors had a lot of skepticism:
“You’re not at a series A level. But yet you’ve raised a large-ish seed round and are now out raising another seed round after a couple years?”
We had a lot of cash in the bank and mild growth, so we weren’t in dire straits. However, ours wasn’t a compelling story.
Ultimately, we raised too much to be seriously considered for another seed round, but we raised too little to make it to the Series A level. On top of this, we didn’t have sufficiently phenomenal growth to overcome these obstacles.
If I were to do this over again, I would’ve raised in two tranches: one to get to product/market fit, and another to scale to a series A milestone.
The Seed Round in Two Stages
Seed rounds can be classified into two stages. The first stage is to get to product/market fit (the true “Seed”). The next stage is to scale to a Series A milestone (let’s call this the “Growth Seed”).
Today’s average seed round amounts are always much bigger than what it takes to get to product/market fit, but the remaining amount after achieving PMF is not enough fuel to get to competitive Series A-caliber metrics.
This is why there are several companies today who raised $750K-$1.5M seed rounds one to two years ago, who are now seeking to raise what’s currently called a variation of Seed Extension/Seed Plus/Second Seed.
These companies are in the tough position of trying to refuel themselves to hit their Series A milestone — like a rocket running out of fuel just before reaching space. Inconvenient — perhaps deadly — timing.
If you don’t have product/market fit, now’s the time to think about how much runway you might need to get to PMF.
How do you know you have PMF?
4 Indicators You Have Product-Market Fit
- Customers that love you as evident from repeat sales or intent to repeat (hard to measure but worth trying)
- A market that’s big enough to get more of that same type of customer
- A strong understanding of your unit economics (cost of customer acquisition, sales cycle, growth rate, CAC payback period, retention, etc.)
- Diversified customer acquisition channels that give you a sense of what will scale if you are currently relying on non-scalable customer acquisition channel(s) for all of your sales. For example, if you’re getting all your conversions from a total of 5 Google keywords, this will undoubtedly have a ceiling in the near-term, or if you’re not even experimenting with paid acquisition channels.
(For LOTS MORE on #s 3 and 4, please see Juan Martitegui’s post on 23 Campaigns Every Startup Should Run to Gain Immediate Traction – and Unit Economics).
If you have not reached PMF, you’ll want about 12-24 months of runway to get to PMF with as little burn and headcount as possible. If you’re close, you may need less runway before raising your next seed round.
In either case, the number you’re raising at this stage is probably $250K-600K. Keep in mind throwing more bodies towards getting to PMF doesn’t necessarily make the cake bake faster.
If you’re at or very close to PMF, this means you have a solid idea of your unit economics. You know that $1 into the business means in X months, you’ll get $1.01 out (for pre-Series A companies, you should look for your payback period to be ~6 months to be considered healthy. Otherwise, you’ll find yourself having to raise a lot of capital and give up a lot of equity).
You also know your rough growth rate.
Based on this knowledge, you can calculate how many months it will take for you to get to the series A level and, factoring in customer acquisition spend and increased head count, how much money you’ll need. Be sure to add in 50-100% buffer as well in case things don’t go as planned.
Series A Is a Moving Target
Over the last 3-5 years, Series A level has become a fast-moving target.
For context, in 2011 when Elizabeth raised for LaunchBit and I, Tim raised for PostRocket, $1M ARR (assuming other decently healthy metrics) was the magic mark for a competitive Series A deal, but now that target is $1.5M-2M. It may be smart to assume an even higher milestone needed by the time you are ready to raise your A round.
Additionally, since every company is different, when you calculate run rate for these purposes, use your net income. Marketplace / Ad Tech / margin-based businesses will therefore have to push more overall sales than a SaaS business, for example, to get to the Series A level.
For your Seed Growth round, you will most likely need to raise at least $1.5M maybe even up to $2.5M. Seed rounds are getting much larger now, because the bar for the A round is higher.
But, if you’re not at P/M fit, it’ll not only be difficult to raise this large of a round, it also won’t make much sense because you won’t have a great idea of how to use the money productively.
As you’re thinking about goals for 2015, prioritize raising the appropriate amount for your startup’s stage. Know where you’re at, and remember: a pre-product/market fit seed is different than a growth seed.